Household spending is more affected by house prices and changing debt levels in Ireland than in other countries, according to new research.

As a result, large variations in house prices, such as those experienced in the Irish market since the economy collapsed in late 2008, are likely to have a significant impact on the real economy.

It also found the decision to reduce household debt levels is found to have negative implications for consumption.

In addition, when examining household deleveraging patterns (debt repayment), the analysis suggests it is a relatively affluent cohort of the mortgaged population who are more likely to engage in deleveraging.

This suggests certain less-well-off sections of the mortgaged population are likely to remain significantly indebted while unable to address their leveraged position.

The research paper, Consumption and the Housing Market: an Irish Perspective, by Kieran McQuinn of the ESRI and Yvonne McCarthy of the Central Bank of Ireland, examines the relationship between the Irish housing market and the real economy.

Real economy

The authors set out to achieve a greater understanding of the links between housing, the real economy and financial sector developments.

The paper analyses two unique micro datasets about Irish households with mortgages to estimate the impact changes in housing wealth are having on consumption, and the implications of household indebtedness on consumption.

“Both issues are central to achieving a greater understanding of developments in the Irish housing market and the real economy,” Mr McQuinn said. “The recent financial crisis has highlighted the relationship between the Irish housing market, real economic activity and key fiscal variables. Micro-level information provides rich insights into the nature of these relationships, particularly in light of the financial crisis.”

The results suggest that as household income levels begin to recover, consumer demand may be somewhat constrained. “More generally, the importance of debt levels themselves for consumption behaviour . . . illustrate an important linkage between financial sector developments and the real economy.”

Understanding these linkages is “highly important when framing budgetary considerations”.

Negative equity

According to the paper, estimates suggest that almost 400,000 Irish properties are in negative equity.

However, a report by economist Jim Power for the Sunday Independent last weekend suggested 24,000 Dublin homeowners have moved out of negative equity in the past two years due to rising house prices, while up to 30,000 more could move into positive territory by 2016.

The result of this research comes as confidence in the economy nose-dived last month, falling back to its lowest level since last November.

The latest KBC Bank Ireland/ESRI Consumer Sentiment Index fell to 79.4 in May, having jumped to a seven-year high of 87.2 the month before. In addition, the three-month moving average fell for the first time in over a year, to 83.2 from 85.3 in April.

KBC’s chief economist, Austin Hughes, said there were a number of explanations that might account for the weakening in sentiment, including a re-assessment of financial circumstances on the back of the local and European elections.